SUM CHEUNG WAI v. TSUI HIN YUET AND OTHERS

HCMP 1707/2010

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1707 OF 2010

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J U D G M E N T

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Introduction

1.  I have before me an originating summons seeking an order pursuant to section 100 of the Companies Ordinance for an order that:

“1. Pursuant to Section 100 of the Companies Ordinance (Cap 32) that the Register of Members of the above‑named Company may be rectified by striking out the name of the 1^st and 2^nd Respondents therefrom as the holder of the entire issued shares of the said Company and by inserting in lieu thereof the name of the Applicant as the holder of the said shares;

…”

2.  In short, I shall go into more detail later, the application arises in the following circumstances.  The Company was incorporated with 2 shareholders, the 1^st Respondent and his Wife the 2^nd Respondent. The memorandum of association shows them as having 7,000 and 3,000 shares respectively.  The issued shares are recorded in the audited financial statements of the Company as fully paid up.  It is the Applicant’s case that in about May 2004 he agreed to take over the Company for the purposes of starting up and conducting his own ladies lingerie business.  He was given the box containing the Company’s shareholders register, share book, seal and chop.  It transpired when this was produced at trial that the 1^st and 2^nd Respondents names had not been entered in the share register and that no share certificates had been issued.  However, it is not in dispute that they are shareholders. The Applicant was made a signatory to the Company’s bank account, which could only be operated if the chop was applied, which as I had mentioned was in the Applicant’s possession.  It is not suggested that there was another chop and it is not in dispute that until the Parties fell out, and the 1^st Respondent caused the Applicant to be removed as a signatory to the Company’s bank account, only the Applicant operated the account.

3.  The Company commenced business in 2004.  It continued under the sole management of the Applicant until the present dispute arose.  As a consequence of the dispute I understand the Company has effectively ceased operating.

4.  The 1^st and 2^nd Respondents’ case can be summarised as follows.  They own and the 1^st Respondent operates a company which manufactures and trades lace called Zenith.  The 1^st Respondent has known the Applicant since about 1998.  The Applicant worked at that time for a company called Trans Eurasia, which was in the ladies undergarment business.  They became friends.  In 2003 they established a partnership to carry on business trading lace in Shanghai.  This business was a failure.  The 1^st Respondent wished to start a ladies’ undergarment business and suggested that the Applicant run it on his behalf and take a stake in the business.  As the business was to be of a different nature to Zenith’s business he decided to use a new company.  As he and his Wife had owned but not used the Company since August 2000, the 1^st Respondent decided to use it.  It was agreed that the Applicant would take a 40% share in the new venture.  The agreement was not recorded in writing.  No steps were taken to register the Applicant’s interest in the Company because he wished to keep his interest in it a secret from Trans Eurasia, who he had left in March 2004, because of restrictive covenants in his employment agreement.

5.  The 1^st and 2^nd Respondents acknowledge that the Applicant ran the Company and did so successfully.  In 2007 and 2008 they began to have some differences in relation to the expansion of the Company’s business and in May 2009 he told the Applicant that he wished to leave the partnership and offered to sell him his shares.  The resulting negotiations proved unsuccessful and have resulted in the Applicant making the current unfounded claim that it had been agreed in May 2004 that he was to take over ownership of the Company.

6.  Whilst much of the relevant facts are in dispute both Parties agree that the current shareholding recorded in the memorandum of association is not what was intended and that the share register needs to be completed either to record the Applicant as the sole member of the Company or to reflect the beneficial ownership of the Company asserted by the 1^st and 2^nd Respondents, namely, that the Applicant owns 40% of the issued shares of the Company and that the 1^st and 2^nd Respondents own 30% respectively.

7.  In his written opening submissions Mr Alan Leong SC argued that section 100 was the wrong procedure to resolve a dispute of the type that arises in this case.  However, as the 1^st and 2^nd Respondents have not previously raised any objection and had consented to many of the procedural orders that have been made he was content for the trial on the understanding that in the event that his clients prevail the Court would make a declaration that the beneficial ownership of the 10,000 issued shares in the Company was as asserted by his clients.  Before the close of trial the Parties (the Applicant was represented by Mr Barrie Barlow SC) had provided to the Court draft orders which they invited the Court to make if their respective client was successful.  Both Parties agreed that the form of order proffered by the other was the correct form of order to make if I found against them.

8.  As I have already mentioned there is no written record of what the parties agreed in May 2004.  There is only one document, which I explain later, that directly supports either Party’s case.  The contemporaneous documents are consistent with what is not in dispute, namely, that the Applicant ran the Company and that the 1^st and 2^nd Respondents remained as a matter of record its directors and shareholders and as such signed its financial statements when they came to be prepared.

9.  Determining the dispute between the Parties, therefore, involves an assessment of the credibility of their respective cases taking into account the matters about which the Applicant and the 1^st Respondent were cross-examined and their credibility as witnesses.  It is, of course, for the Applicant to prove his case on the balance of probabilities.  I turn to consider the Parties’ evidence and cases before me in detail.

Applicant’s Case

10.  The Applicant’s evidence was that in 2003 he was the head of a department at Trans Eurasia.  He had known the 1^st Respondent through work since 1998 and they had become friends.  The Applicant trusted the 1^st Respondent.  He says that in early 2003 the 1^st Respondent raised with him the idea of working with the 1^st Respondent in a partnership to be conducted through the 1^st Respondent’s company Sailite Embroidery Lace Co Ltd (“Sailite”).  The Applicant says that at this time he had very little understanding of the legal aspects of a limited company’s organisation.  His lack of sophistication and readiness to trust the 1^st Respondent is demonstrated, he argues, by the fact that when he went into business with the 1^st Respondent nothing was recorded in writing and there is no evidence of any legal entity ever being formed by the 1^st Respondent to carry on business in Shanghai in which the Applicant had any legal interest.  The degree of trust he reposed in the Applicant is further demonstrated by the fact that when in early 2004 the 1^st Respondent told him that the Shanghai business was not viable and he intended to close it he accepted what he was told without question.

11.  In early February 2004 the Parties agreed that the Applicant should take charge of the Company to operate his own business and would continue to collaborate with the 1^st Respondent on other businesses.  The Company was formed in August 2000.  The memorandum of association and the subsequently produced audited financial statements record 10,000 shares as being issued fully paid.  The 1^st and 2^nd Respondents did not pay for the shares.  Instead the general ledger of the Company recorded a director’s debt for $10,000.  The Company was in other words a shell company.

12.  On 14 February 2004 the Parties signed a document headed “Donna’s Bodywear Co. Ltd, Minutes”.  It recorded amongst other items that the Applicant would sign all official documents on behalf of the Company.  On 15 March 2004 the Applicant left Trans Eurasia.  He was given all the Company’s books including the share certificates book and register of shareholders, the Company seal and chop.  On 16 March 2004 the 1^st Respondent procured his brother-in-law, Wang Shou Wen, to advance $1,000,000 by way of working capital.  On 24 March 2004 the Applicant becomes a signatory to the Company’s bank account.

13.  Up until 31 March 2004 the Company had not traded, although its ledger records it having incurred $64,090.84 in administrative expenses.  These were paid by Zenith.  The Company in due course repaid them.

14.  In April 2004 the Company commenced business trading in ladies lingerie buying from companies in the Mainland and selling overseas mainly to customers in Europe using purchaser’s payments to finance buying costs.  The Applicant managed all the Company’s affairs.  The 1^st and 2^nd Respondents had no involvement whatsoever.  The Applicant received a modest salary.  No directors’ fees were paid and no dividends were declared.

15.  By the end of the 2006/07 financial year, namely 31 March 2007, the Company had sales of $52,517,000 and retained profits of $3,120,000.  The Applicant’s current account showed debits of approximately $43,300,000 and credits of approximately $41,511,000.  The Applicant, through his director’s account, assumed responsibility for the $1,000,000 loan from Mr Wang, which was repaid on 12 January 2007.

16.  In mid 2007 the Applicant says that he had dinner with the 1^st Respondent and suggested regularising the control of the Company.  He says that the 1^st Respondent was evasive.  He did not press the matter.  In cross-examination he explained that he decided to wait for a suitable occasion on which to raise the matter again.

17.  The Company’s business continued to grow.  For the financial year ending 31 March 2009 sales reached approximately $86,080,000 and retained profits totalled approximately $8,190,000.

18.  In late 2008 the Applicant was considering purchasing a new software package on behalf of the Company, but was not able to sign a contract because he was not a director.  This caused him concern and in early May 2009 the Applicant consulted a lawyer about the Company and was told, he says, that he needed to regulate its ownership because, self‑evidently one might think, his interest in it was not protected.  This was the position even on the Respondent’s version of events.

19.  On Friday 29 May 2009 the Applicant and the 1^st Respondent met in Zhuhai and again discussed regularising the Company’s ownership.  By this time the Applicant says he began to suspect that the 1^st Respondent would not honour the agreement made in 2004 that the Company was the Applicant’s company.  He was concerned that the 1^st Respondent might paralyse the Company.  This he thought was a real risk because the amount of business being conducted between the Company and Zenith had reduced considerably in recent years.  He wished to resolve the matter amicably however and offered to pay the Respondent 40% of the total assets of the Company.  The 1^st Respondent wanted to see the Company’s balance sheet.  On the following Monday the Applicant obtained the most recent balance sheet from the accounts clerk, Heidi Wai.  The Applicant showed the 1^st Respondent the Company’s management accounts balance sheet.  Ms Wai was employed by Zenith, but the 1^st Respondent had agreed to her working on a part time basis for the Company helping with its accounts.  The Applicant paid her personally and was reimbursed by the Company.  As I will explain later audited financial statements did not at that time exist.  The Applicant says that based on the figures shown on that sheet it was agreed that the 1^st Respondent and 2^nd Respondent would be paid $5,461,489.32 divided into 4 instalments. The Applicant wrote 3 post dated cheques made payable as requested by the 1^st Respondent to a Mr Wong Kong Tung, who the 1^st Respondent describes in his affirmation as “a middleman who would help people with cross-border businesses to channel money between Hong Kong and China”.  He gave them to the 1^st Respondent.  The Applicant says the 1^st Respondent then changed his mind and demanded $8,000,000 and did not present the cheques. 

20.  The financial statements for the period 2000 to 31 March 2004, and the subsequent financial years ending 31 March 2009, were audited in 2009 and dated August 2009.  The Applicant says that the delay in preparing the accounts is attributable to Heidi Wai telling him when he asked that the auditors, who were also Zenith’s auditors, said that their preparation was not necessary until a tax return demand was received and for some unexplained reason this did not happen.  Eventually the Applicant asked that they be prepared.

21.  They are unqualified and there is no suggestion that the auditors had any difficulty in accessing the Company’s books and records.  All the financial statements were signed by the 1^st and 2^nd Respondents as the Company’s directors confirming them to be accurate.  I also note that it is the 1^st Respondent’s own evidence that Ms Wai provided him with copies of the general ledgers of the Company.

22.  The rejection of the cheques by the 1^st Respondent added to the Applicant’s increasing scepticism about the 1^st Respondent.  The Company’s premises were one floor below Zenith.  He was concerned that the deteriorating relationship between him and the 1^st Respondent would cause disruption and, therefore, he leased new premises from which the Company could operate.

23.  By November 2009 the earlier cheques were expiring.  The Applicant wrote 4 new cheques to replace them.  They were drawn on the Company’s bank account because, he says, he did not appreciate at the time that this was impermissible and that he should personally pay for the purchase of the shares.  In any event they were not presented.

24.  In July 2009 he had established a new limited company Beaute‑Intime Apparel Company Limited (“Beaute-Intime”) to develop business within the Mainland.  By early 2010 he thought it prudent that Beaute‑Intime should accept some of the new orders from overseas clients to reduce the risk of the 1^st Respondent disrupting the Company’s business.

25.  An exchange of emails was commenced by the 1^st Respondent on 18 March 2010 in which the 1^st Respondent purports to justify his request for payment of $8,000,000.  The exchange continued until July.  Neither Parties’ position changed.

26.  Since August 2010 when the Applicant was removed as a signatory to the Company’s bank account the Company has ceased active business and has been following up on contracts signed in the period prior to August 2010.

27.  By September 2010 the Applicant’s patience had run out and he issued these proceedings on 8 September 2010.  On 15 September 2010 the 1^st Respondent’s solicitors filed with the Companies Registry a notification of increase in the nominal share capital of the Company and allotments of shares with the apparent intention of recording the shareholding of the Company as being in line with the 1^st Respondent’s present case.  There was no allotment of shares to the Applicant and the return was clearly false, a subject I return to later.

28.  In June 2012 the 1^st Respondent made a complaint to the Commercial Crimes Bureau that the Applicant had stolen $17,000,000 from the Company between 2005 and 2008.  The Applicant was arrested in January 2013 and released on police bail.

1^st Respondent’s Case

29.  The 1^st Respondent’s case is rather simpler.  He says that since 2000 he had been talking to the Applicant about helping him expand his business into women’s undergarments.  The Applicant was hesitant and he invited him to join in a new partnership with Sailite, which he envisaged would be an easier business venture and, I assume, thought would build the Applicant’s confidence.  I have already explained that this proved not to be the case.  In any event the 1^st Respondent continued to talk to the Applicant and proposed that he join a new company to develop a woman’s undergarments business in which he would hold a 40% interest.  This was agreed and this is how the Applicant came to be involved with the Company.  The reason that the Applicant was not immediately made a shareholder and director of the Company was because he was concerned about restrictive covenants with his previous employer Trans Eurasia.  He says, however, that he asked an account’s clerk, Ms Yip, to record the necessary arrangements and that she wrote down on a post-it sticker the proportions of shares of the Applicant and the 1^st and 2^nd Respondents were to own.  This has been retained and he has exhibited it.  The implication of the Applicant’s affirmation evidence is that he did this in about March 2004 or not long after.  However, in her affirmation Ms Yip states that she was instructed to do so on 3 October 2007.  The Applicant did not know this when he made his 1^st affirmation in which he states in paragraph 20 that in 2007 he asked over dinner for the Company’s records to be regularised to reflect his ownership.  Mr Barlow objected to admission of Ms Yip’s evidence on the basis that it was a statement made behind the back of the Applicant, which could not be meaningfully tested in cross‑examination and therefore should be excluded on the grounds of unfairness[1]. I allowed the evidence of Ms Yip.

30.  The 1^st Respondent provided the initial capital through the advance of $1,000,000 from his brother-in-law.  The 1^st Respondent allowed the Company to operate from premises rented by Zenith and the Company reimbursed the rent.  The Company moved premises in 2005.  The new premises were again rented by Zenith.

31.  He points to an email sent by the Applicant on 9 July 2004 to him asking if he agreed to the Company’s name being listed at the address of Glory Force Brassieres & Underwear Ltd in the Mainland.  This company was owned by an associate of the Applicant.  The Applicant thought that associating the Company with a factory would give clients more confidence in it.  I note in passing that this is not what the email says.  It simply says “can you see name in China” and attaches a photograph of what appears to be an entrance board.  

32.  The 1^st Respondent acknowledges that the Applicant ran the Company and he accepts that he did a good job.  He was paid a modest salary initially of $10,000 rising to $20,000.  It was the Applicant who suggested retaining profit in the Company to fund its expansion rather than declare a dividend to which he agreed, because he had in mind the Company opening a factory in the Mainland.  The Company repaid the $1,000,000 in January 2007.  He was updated, he says, from time to time by the Applicant on the financial affairs of the Company.  In 2006 he suggested registering the Applicant’s interest in the Company, but the Applicant said he would like to focus on the Company’s business and they need not worry about the shareholding.

33.  He repeatedly raised the subject of opening a factory in the Mainland between 2007 and 2009 with the Applicant but he kept on giving excuses for delaying this.  The 1^st Respondent felt the Applicant was hindering the development of a healthy business.  Eventually the 1^st Respondent came to doubt whether the Applicant wished to operate the Company in accordance with their agreement.  At the dinner on 29 May 2009 the 1^st Respondent said he and his Wife wanted to exit the Company.  The Applicant agreed and offered to pay $8,000,000 for their interest.  The 1^st Respondent agreed.  The Applicant then reneged on this deal the following week proffering 3 cheques totalling $5,461,489.32.  He refused to accept the 3 post dated cheques.  Their negotiations continued until well into 2010 ultimately proving unsuccessful. 

34.  It is the 1^st Respondent’s evidence that, unbeknown to the Applicant at the time, Ms Wai had provided him with copies of the Company’s ledgers shortly after the present application was issued on 8 September 2010.  The 1^st Respondent states in his 2^nd affirmation that having gone through the ledgers he concluded that they showed that the Applicant had taken approximately $17,000,000 from the Company, which is not accounted for.  He goes onto suggest that he had grave doubts that the money had been used to settle Company expenses and accordingly reported the matter to the Police in June 2012 and as I have already explained the Applicant was subsequently arrested.

35.  Other than for the sticker written by Ms Yip there are no contemporary documents that record either party’s version of events.  So far as Ms Yip’s note is concerned I consider it of little evidential value as it was written 3 years after the Parties discussions in the first half of 2004 and, it seems likely, written after the Applicant first raised his wish to have the Company’s records amended to reflect his ownership and is, therefore, entirely self-serving.

Analysis

36.  The Applicant’s evidence in cross-examination was clear and to the point.  It fleshed out very helpfully the rather thin evidence contained in his witness statement.  He explained that in 2004 he had very little experience of how businesses were organized legally.  His job had been as a manager of a department of Euro Asia.  His job did not involve him having to understand such matters.  His inexperience in this regard is demonstrated by the fact that even on the 1^st Respondent’s case when he became a partner with him in the Shanghai business involving Sailite nothing was recorded in writing and when the 1^st Respondent told him that the business venture was not viable and should be closed he went along with the 1^st Respondent’s suggestion without question.

37.  The Applicant says that in early 2004 he trusted the 1^st Respondent, who he considered a friend.  He was interested in having his own business rather than forming another partnership.  His understood that the attraction to the 1^st Respondent of him, the Applicant, establishing his own ladies underwear company was that it would have synergy with Zenith and would place orders with it.  It is not in dispute that this is what happened until one of the Company’s major clients, Next, discovered that Zenith had been using one of its designs, which it had acquired as a result of an order placed with Zenith by the Company, to produce items which it had sold to one of Next’s competitors.  Next insisted that the Company stop placing orders with Zenith. It is also the 1^st Respondent’s case that he was interested in doing business with the Applicant because he thought he was able and there were opportunities in the ladies undergarment business.

38.  The 1^st Respondent gave the Applicant the Company, which at the time was dormant, and helped him along with a loan of $1,000,000, which in due course he paid back in full along with the expenses which had been incurred by the Company prior to it being given to him.

39.  It is common ground that the Applicant ran the Company by himself. There is no suggestion that the 1^st Respondent had any involvement in building or managing its business.  The 1^st Respondent’s involvement was limited to sub-letting part of its premises to the Company and allowing one of its staff to work part time as an account’s clerk for the Company.  The 1^st Respondent did nothing to suggest prior to 2007 that he thought he had any direct interest in the Company.

40.  The Applicant’s story amounts to this.  The 1^st Respondent helped him start a business, which if successful would in turn generate business for Zenith, which it did.  In my view this is a credible story and consistent with what happened.

41.  The Applicant says that in 2007 he realized that he should regularize the Company’s affairs.  It gradually became clear to him that his trust in the 1^st Respondent was misplaced.  He appreciated that the 1^st Respondent had legal control of the Company and was in a position to damage its business.  He decided to pay him to complete the transfer of the shares into his name.  He thought this was better than getting into a fight.  This is why he made the offer on 30 May 2009.

42.  The Applicant was cross-examined on why he dealt with the 1^st Respondent so respectfully, for example in their exchanges of emails, if he believed that he was trying to cheat him.  The Applicant explained, credibly in my view, that the thought that this was the better way of addressing the problem. There, however, came a point in time at which it became clear that a reasonable compromise could not be achieved.

43.  I found the Applicant’s evidence clear, plausible and convincing.  I thought him an honest and impressive witness.  This was in stark contrast to the 1^st Respondent.

44.  The 1^st Respondent was an unimpressive witness.  My impression was of a man for whom his own immediate self‑interest represented reality.  He seemed to have little ability to reflect objectively on events and understand their implications.  As a result he was unable to understand and answer many of the questions put to him by Mr Barlow in cross‑examination.  This was particularly true in the case of the report to the Police.  The Company’s accounts had been audited by Zenith’s auditors on the basis of ledgers, the contents of which he says led him to conclude that the Applicant had probably misappropriated significant sums from the Company.  It is inherently unlikely that Zenith’s own auditors would have failed to notice problems of the magnitude complained of by the Applicant.  In cross-examination he seemed to show no understanding of this at all and he was unable when invited to do so to point to a single item in the ledgers, which he thought recorded an improper withdrawal of funds by the Applicant. It was also quite clear that he had made no effort at all to ascertain whether his suspicions were well founded before reporting the matter to the Police.  He had not, for example, done the obvious thing and talked to the auditors about his concerns.  This points strongly to the conclusion that his report to the police was malicious and made in order to discourage the Applicant from pursuing the present action.  It also suggests that the 1^st Respondent is a man of little integrity.

45.  In conclusion, I am satisfied that the 1^st and 2^nd Respondents did agree to pass ownership of the Company to the Applicant in or about March 2004 and that there should be an order in the terms of the draft handed up at the end of the trial, namely,

1. Pursuant to section 100 of the Companies Ordinance (Cap 32) the Register of Members of the 3^rd Respondent (the “Company”) shall be rectified by entering the name of the Applicant as the sole shareholder of the Company, holding the 10,000 issued and paid up shares in the Company from the 1^st day of April 2004 onwards.

2. The Applicant is hereby authorised to rectify the Company’s Register of Members as aforesaid and to inform the Registrar of Companies accordingly.

3. Each of the purported Notification of Increase in Nominal Share Capital dated the 15^th day of September 2010 and the purported Annual Return dated the same date, which the 1^st and 2^nd Respondents caused to be filed in the Companies Registry on 20 September 2010 are invalid, null and void because they misdescribe the true state of the Company’s Register of Members which is that which is declared in paragraph 1 of this Order.

4. The Applicant’s costs of these proceedings shall be paid by the 1^st and 2^nd Respondents and they are to be taxed if not agreed.

5. There shall be a certificate for 2 Counsel.

46.  Before ending this judgment there is one further matter I wish to address.  As I have explained earlier in this judgment on 15 September 2010 the 1^st Respondent’s solicitors filed at the Companies Registry a notification of increase in nominal share capital and an allotment of shares.  I accept the 1^st Respondent’s evidence that this was his solicitors’ idea.  It is not in dispute that there was no allotment at any time of shares to the Applicant.  This was known to the solicitors.  It was entirely improper of them to file at the Companies Registry a document which they knew was false and I will report the matter to the Law Society.